Did Lobbying Cause the Financial Crisis?

The HBO docu-drama Too Big To Fail and the book by Adam Ross Sorkin by the same title are billed as the defining history of the financial crisis. But it may be time to rewrite history again.

Recently, there has been some griping about financial lobbying because it seems the big banks are attempting to roll back every regulatory change that has been made post-Lehman Brothers. OK, we all probably agree that there will be some rules that have been instituted in the wake of housing bust that will end up being mistakes. But that can’t be all of them. Yet, a new study suggest that lobbying by financial firms might be more dangerous than just rolling back Dodd-Frank regulatory reform bill. Lobbying may have caused the financial crisis itself. Here’s why:

It always been clear that Wall Streeters wanted Washington to stay out of its business. In the mid-2000s, then-head-of-Goldman-Sachs Henry Paulson pushed for a rule that would allow financial firms to increase their leverage. Sandy Weill was a big player in the elimination of Glass-Steagall, which forced investment banks and commercial banks to remain separate. What has not been clear is that regular lenders played a role in pushing for deregulation as well, and in an effort to make bad loans.

The current story line of the financial crisis is that free-market thinking Republicans and Democrats pushed to have the financial markets deregulated, assuming Wall Street profits would lead to Main Street profits. That started as a philosophical move, but then become a practical reality after the dot-com boom. Alan Greenspan, who as the head of the Federal Reserve was supposed to be the lending watchdog, made it easier for lenders to make whatever type of loan they wanted in order to get money into people’s hands and into the economy. That regulatory void set the stage for the wild lending of the housing boom – undocumented berry pickers getting half-million loans. Lenders are certainly not blameless in this scenario. But it is easier for bankers to make the case that these risky loans were the product of regulatory changes that politicians and others were encouraging. They didn’t make the rules afterall. So the story goes.

But it appears, once again, the banks are perhaps more to blame than earlier thought. A new study published this week by the National Bureau of Economic Research argues that banks were an active participant in deregulation, pushing for weaker rules that allowed all those ill-advise mortgage loans. The paper is called A Fistful of Dollars: Lobbying and the Financial Crisis, and it is by three economists at the International Monetary Fund. The IMF economists found that lenders that lobbied the most also tended to make riskier loans. They also found that the areas of the country dominated by lenders who spent the most lobbying dollars also tended to higher rates of default. Lastly, if you thought there was connection between Washington connections and bailouts, you would be right as well. The economists found that the firms that lobbied the most were also the most likely to get bailout cash.

The authors say they can’t exactly say that lobbying caused bad loans. It may have happened at the same time. But what is clear is that lobbying especially by financial firms is perhaps more dangerous than we thought. The really scaring thing is that unlike say collateralized debt obligations or option-ARM mortgages lobbying didn’t disappear in the financial crisis. In fact, last year, financial firms spent more time and money lobbying Washington then ever before. Be prepared to read more about lobbying in Still Too Big To Fail, the Financial Crisis Part Duex.